J.P. Morgan's Equity Strategy (Sept 2011)

On Sept 7, J.P.Morgan came out a report titled "Global Markets Outlook and Strategy". Here, we would like to share the equity strategy written, which we think is the most sought after reference for investors to strategize during this uncertain times. Below is the excerpt from the said report:

"We believe perceptions of a US recession will continue to weigh on equity markets and we thus keep a low amount of risk in our equity portfolio and reduce beta to negative."

"The most likely positive catalyst for equity markets in the near term lies with US economic data. This is not happening yet. Our US Economic Activity Surprises Index remains in negative territory, where it has been for 5 straight months (Chart 1). We need to see this index moving to positive territory, and US economic data surprising on the upside, for equity markets to sustain a recovery."

2 reasons why Under-performance

The August market slump saw emerging market (EM) equities and small caps under-performing, exhibiting their traditional high beta during recessions or crises. There are 2 reasons for this under-performance.

1. During expansion and market rally phase, investors became overweight the assets with the highest beta. The economic turnaround then forces them to get back to neutral, inducing more selling in EM and small caps.
2. Small caps and EM are both less liquid markets, amplifying the impact of a given amount of selling. This happened even in periods when the crisis emanated clearly from developed markets and not from EM. The beta, position, and liquidity forces dominated the source of the crisis in driving relative performance.

The Strategies...

Rule-based trading strategies tend to perform better in highly uncertain environments. We take more risk on these strategies:

• A US equity sector trading model based on a combination of sector short interest, a contrarian indicator and 11-month return momentum suggests staying long in Energy and Materials vs. Financials and Staples.
• Our Cyclical vs. Defensive global sector trading signal based on the monthly change in global PMI is currently recommending an UW in Cyclical vs. Defensive sectors.
• Our EM vs. DM equity signals based on relative IP growth and 2-month return momentum are currently neutral in EM vs. DM equities
• Our model for allocating between the US and Euro area equities currently suggests a long in US vs Euro area equities currently hedged

Why chose ASEAN economies vs. China?

• ASEAN countries are in a sweet spot with inflation below the central bank target zone, strong currencies and healthy growth. Emerging markets for now are a non-BRIC story.
• We see a high risk of disappointment in China. The consensus view is that growth is the priority. But with wage inflation signaling healthy employment conditions and public concern about the rising cost of living we see a high risk that policymakers focus on price stability rather than growth.
• China's 2Q fixed asset investment (FAI) to GDP ratio was 53%. The re-acceleration in 2H11 growth is based on affordable housing and FAI projects. The result is FAI to GDP above 60%, a level that could result in more overheating.

UW: Underweight

OW: Overweight